Didn’t Notice The Proposed Changes To The SLR? Don’t Worry, Most Markets Didn’t Either

The US Treasury released its first report (under Trump) on re-examining financial regulations and their impact on economic growth. The publication was little noticed because most people don’t much care about Supplemental Leverage Ratios (SLR), though they should.

For decades, regulators allowed banks to operate under Basel rules as if capital ratios were sufficient criteria for identifying risks, only to suffer the worst global monetary panic since the Great Depression. Some people did notice that banks like Bear Stearns and Lehman Brothers were by all regulatory standards “well capitalized” and yet their balance sheets were hugely extended, often with leverage ratios of 33 even 35 to 1.

The ability of banks to be able to manipulate capital ratios was at the core of the eurodollar system’s global expansion especially after 1995 (JP Morgan; RiskMetrics). If you understand what goes on in constructing a bank balance sheet (as I will go through in great detail in my upcoming series, Eurodollar University), there was no inconsistency in blown out leverage ratios at seemingly “well capitalized” banks.

This placed a great deal of importance on especially derivatives that served the function of “regulatory capital relief”; which simply means the ability to take whatever asset and describe it in the most charitable way possible so as to reduce the capital charge of that asset. This is not as it may seem in my description here utterly and totally nefarious; as with all things, even the best ideas can at times get far out of hand and be bastardized toward purposes either different or to extremes other than originally intended.

If a bank has a choice of lending in a mortgage at a 100% risk-weighting, or buying an MBS with similar characteristics at a 50% or even less risk-weighting, the choice is obvious. Flipping the capital ratio around, for the same amount of capital a bank can hold double its leverage (hold twice as much assets) at a 50% ratio as 100%. Therefore, the ability to do that is paramount, even if capital ratios look pristine in each case.